Embedded Finance: The Threat to Banks or the Opportunity of a Lifetime?

Aug 11, 2023

The financial services landscape is undergoing a significant transformation thanks to the emergence of embedded finance. This innovative concept is still in its early stages but is growing rapidly, presenting both opportunities and challenges for traditional banks. In this blog post, we will explore what embedded finance is, its potential threats to banks, and the opportunities it presents for them.

What is Embedded Finance?

At its core, embedded finance refers to the integration of financial services into non-financial platforms or businesses. It allows customers to access and use financial products and services seamlessly within the context of their everyday activities without the need to rely on traditional banks. For example, Facebook offers Facebook Pay, which allows users to transfer money directly within its app. Similarly, apps like WeChat in China have effectively become digital wallets, allowing users to make payments, transfer money, and even invest in mutual funds. Other examples of embedded finance include construction companies offering their own loans and travel booking sites offering insurance products integrated seamlessly into the checkout process.

Retailers are getting into the game as well. For instance, UK-based multinational banking and financial services organization, HSBC, partnered with Marks & Spencer (M&S) to launch the M&S Bank, which offers a suite of financial products including current accounts, mortgages, and credit cards. Similarly, in the United States, Walmart has partnered with Capital One to provide Walmart-branded credit cards. By offering their own branded credit cards, these retailers not only generate revenue from interest and fees, but they also incentivize loyalty and increase the amount of money customers spend in their stores.

Alternative Payment Options as a Threat….

Embedded finance represents a shift from traditional financial services, where companies are no longer just providing standalone products but are integrating these services into other parts of a customer’s life, often through technology platforms. That means non-financial companies can now offer financial services to their customers without having to become a bank themselves. For example, e-commerce platforms like Etsy, eBay, and Amazon offer embedded payments. Sellers on these platforms can receive payments directly through the platform without having to set up their own payment systems. Additionally, platforms like Shopify offer a wide array of financial services including loans, payments, and even shipping.  Neo-banks and fintech companies like Chime, Monzo, and Revolut are integrating banking services into digital platforms. They often offer features like budgeting tools, automated savings, and easy peer-to-peer payments.

Every Company Will be a Fintech Company

Some industry experts believe that, eventually, every company will provide financial services, such as loans, deposits, and insurance payments.  Angela Strange, General Partner at Andreessen Horowitz, has coined this idea. She cites statistics indicating that consumers no longer love or trust their banks, and the fact that established traditional financial institutions find it challenging to innovate quickly. Therefore, she believes that companies will increasingly derive a significant portion of their revenue from financial services driven by the influx of new, transformative financial infrastructure tools.

“Every company should be thinking about how to leverage financial services to better serve their customers, better retain their customers, and drive more margin.” Angela Strange, General Partner at Andreessen Horowitz.

The benefits embedded finance brings to the B2C experience are clear. For example, if someone uses booking.com to purchase a vacation package that includes airline tickets, hotel, and rental car, they expect to pay one price on the website itself. Imagine if the booking and payment process were separated and the customer would need to pay each supplier individually – not exactly a seamless experience.

The benefits extend to the B2B markets as well. Shopify, which provides website services to merchants for a monthly subscription fee, reported more than one million merchants on the platform and a 21% revenue growth in 2022, with nearly 50% of that revenue coming from financial services. The same “as-a-service” benefits can be found in all areas of financial services, from mortgage applications and student loans to paycheck management and anti-fraud services.

This trend threatens traditional banks as it enables these non-financial entities, such as tech companies or retailers, to establish direct relationships with customers and capture a share of the financial services market. Case in point: Apple’s credit card. With their vast customer bases and deep understanding of consumer behavior, these companies can leverage embedded finance to offer tailored financial solutions that cater to their customers’ needs, potentially eroding traditional banks’ market share.

… Or Opportunity?

However, while embedded finance does pose challenges to traditional banks, it also presents significant opportunities. Bank as a Service (BaaS) is a business model in which traditional banks and other financial institutions leverage their existing infrastructures and licenses to enable other businesses to offer branded financial services. Essentially, BaaS platforms act as a kind of middleman between financial services and companies that want to integrate these services into their offerings, including non-financial companies like retailers, tech firms, and others. The model is mainly B2B2C – business to business to consumer.

Banks can embrace this emerging trend by partnering with non-financial companies and leveraging their expertise and customer base to offer embedded financial services. Partnerships allow banks to focus on their core competencies of risk management, capital, regulations, and operational processes for financial services and leave the front-end and customer management to the partner. By collaborating with these companies, banks can expand their reach and tap into new customer segments. This strategic partnership approach allows banks to remain relevant in a changing financial landscape and capture a slice of the embedded finance market.

By integrating financial services into existing platforms or creating their own platforms, banks can offer customers seamless and convenient financial solutions. For example, a bank could collaborate with a retail company to provide instant loans or installment payment options at the point of sale, enhancing the shopping experience for customers while generating additional revenue for the bank.

To adapt to the embedded finance ecosystem, banks must also invest in technology. The success of embedded finance relies on robust and secure infrastructure, advanced data analytics capabilities, and seamless integration with various platforms. By investing in these areas, banks can position themselves as reliable partners for non-financial companies and provide the technological backbone needed to power embedded financial services.

Another area of opportunity for banks is to carefully consider their value proposition. If they can no longer interact with the end customer directly, how can they ensure that their services remain of value? How can banks ensure their services will not be commoditized and easily swapped for another bank’s offering by their embedded finance provider partners?

The Future Holds the Answer

Looking to the future, the question arises: Is embedded finance a threat that will push traditional banks to the sidelines or an opportunity for them to reinvent themselves and thrive in a new financial landscape? It’s an open question. While embedded finance challenges the traditional model of banks working closely with individual customers (B2C), it also presents a direction for banks to pivot towards business-to-business (B2B) partnerships, collaborating with non-financial companies to deliver financial services to end customers. By embracing this shift, banks can leverage their expertise, infrastructure, and regulatory Compliance to establish themselves as trusted providers of embedded financial services.

Embedded Finance Trends

As embedded finance continues to evolve, there are several trends to watch. Here are just a few:

• Broadening horizons: The expansion of embedded finance into new industries and sectors, such as healthcare, travel, or real estate, presents opportunities for banks to tap into previously untapped markets.
• Expanding integrations: The increasing adoption of open banking and API technologies enables seamless integration between financial institutions and non-financial platforms, facilitating the growth of embedded finance.
• Additional disruptors: The rise of decentralized finance and blockchain technology has the potential to disrupt the financial services industry further, offering decentralized and secure financial solutions that could challenge traditional banking models.

Summary

Embedded finance is undoubtedly a disruptive force in the financial services industry. It poses threats to traditional banks, especially regarding alternative payment methods and the ability of non-financial companies to offer financial services. However, it also presents an opportunity for banks to adapt, innovate, and collaborate with non-financial entities to offer embedded financial services. By embracing partnerships, developing their own embedded finance solutions, and investing in technology, banks can position themselves as key players in the evolving financial landscape. The future of banks will depend on their ability to navigate and capitalize on the opportunities presented by embedded finance.